The Mind of an Institutional Investor

U-Turn For Exec Comp?

Paris, September 13 – Just yesterday, 23 people gathered in a windowless conference room at a convention hotel in Paris. The ostensible reason was to comment on the work of the International Corporate Governance Network’s remuneration (executive compensation) committee The conversation took a quick and sharp turn, however.

It began normally enough, with a discussion of alignment of interests between executives and shareowners, role of a Board’s compensation committee, disclosure of compensation, etc. However, I decided to ask what I thought was going to be an ineffectual verbal challenge.

Why, I asked, do institutional investors keep preaching alignment? We’ve been doing that for two generations and it has not worked. Perhaps it’s time to admit the obvious: Shareowners’ interests and executives’ are not perfectly aligned and cannot be made to be perfectly aligned. Perhaps it’s time to admit that fact and return to an old idea: Management, even senior management, are employees. They ought to be fairly – and I’d say even generously compensated – but they are employees of the corporation not suppliers of capital. Is it simply time to stop trying for alignment and deal with them as highly-compensated employees for whom the board must make a compensation decision, whether in cash, shares, options or whatever. But that means the Board must consider what has become know in Europe as “quantum,” which is shorthand for both “what do all the various compensation schemes add up to” and “how much is enough”. It does not include, however whether options or restricted shares or phantom shares or time-vested grants or performance-grants or deferred comp or three-year vesting rights or any of the other “comp speak” we’ve all come to know far too well over the years. In some ways, by considering the mechanisms of pay, and trying to make them aligned, we’ve emphasized form over substance, and the amount has become a fall-out, rather than a decision.

Surprisingly, I received an amazing amount of support. The comments came quickly, as if a dam had been broken. “We’ve become too complex,” “Even boards don’t know what they’re paying,” etc. Later, in a plenary session, a banker basically admitted as much, saying that for senior bank executives, compensation had become a slot machine: They pull a lever and three years later out comes a trickle of coins or a fountain of folding money.

To be sure, the shareowner community is not about to consign alignment to the scrap heap of history. Nor should we. The fact that alignment is not perfect is to make the best the enemy of the better. But to admit that alignment can never be perfect means that we must insist that the Board use judgment about quantum as well as instruments that align compensation as best it can. And that has been a taboo topic for institutional investors (including me) for too long.